Thursday, 30 September 2010

Saving: vice or virtue

From Mario Rizzo's comment on Coordination Problem (an Austrian blog):
Keynes...does turn certain virtues (like saving) into vices -- from an economic or consequentialist perspective. What is particularly disturbing is that from a long-run perspective surely saving is a "virtue."
But surely it's not. Investment is a virtue; and saving, usually, is what enables investment.

Saving in itself is a neutral act, because one person's savings are another person's debt. In the Keynesian model, attempts to increase saving while investment is falling simply lead to a spiral of shrinking income. It's investment that creates future wealth.

According to the savings identity, total savings does equal investment, but that statement is misleading for two reasons: one, because this definition of investment includes inventory (which may be built up involuntarily, and is not especially "virtuous"); and two, because it hides the effects of savings in one period on investment in the next.

If we could all agree how much saving we wanted to do, and then make the total available as an investment fund available for allocation, then savings really would be virtuous. But that requires a level of coordination which is unrealistic in a complex economy - a problem which I'm sure is easily recognised by commenters on a blog called Coordination Problem!

Price is meant to be the coordination mechanism for allocating economic resources: more savings => lower interest rates (the price of deferred consumption) => more investment. And often that works perfectly. But cognitive economics shows us many flaws in this mechanism. And this is why Keynesian policy, sometimes, might have a role to play.

Where did Ireland's money go?

Whenever I see some huge figure for an institution's "losses" I am suspicious. Ireland has now supposedly spent about 55% of its GDP, or €100 billion, to bail out its banks and buy toxic property assets from them.

But they haven't created anything with this money - it hasn't been spent on goods or services. In fact, it's just a transfer. So where is the money now, and has anything of economic value actually been lost?

Partly the story is similar to that in the UK - lots of people who had a property and sold it in 2007 have made a ton of money. Many of the people who bought the properties have now handed the properties - and the debt - over to the government. But at average Irish house prices, that €100 billion is about 500,000 houses - and surely that number of people did not exit the housing market (in a population of 4.4 million). Even if they had, the government has certainly not foreclosed on (or acquired) 100% of the relevant mortgages.

Beneficiaries in this case: homeowners who sold out, or downsized, at the right point in the market.

New houses have also been built. About 90,000 houses a year were built at the peak of the market, and no doubt lots of them remain unsold. In fact, there was an oversupply of about 250,000 houses at the peak of the market in 2007. Certainly a high proportion of those might have ended up in the hands of the government - but again, surely not all of them?

In this case, the beneficiaries are likely to have been builders and construction suppliers, especially in the mid-2000s.

In fact, lots of the debt acquired by the government is likely to be securitisations of existing mortgages and not new build. In these cases, the lenders who historically held the mortgage asset - or traders who have bought and sold it along the way - will have gained at the expense of the new owner, the Irish taxpayer. So some of the money has simply been transferred to the private sector or out of the country.

So there are three sets of people who have benefited from the property boom (some of whom might have been directly bailed out by the government, but most of whom already had their money free and clear). Old homeowners, builders, and the shareholders of banks inside or outside of Ireland who sold mortgage securities at the right time (not those, like Anglo Irish or Allied Irish, who bought them).


Ireland's property boom was fuelled by an expectation that its economy would continue to catch up with - and perhaps overtake - Germany, the Netherlands and the other richer eurozone economies. And on the assumption of continued immigration. Had that continued, Irish property would still have been worth a fortune, and those who borrowed would have been able to sell off the houses, or refinance, and there would be no problem.

And if the European economy can be restarted, and especially if it can be brought back to its previous trend line (so the output gap closes and Ireland returns to its place as a high-growth overflow supply source for EU-wide demand), all the property assets inadvertently acquired by the Irish government might be worth something after all.

So European Central Bank - it's time to step up. Yes, you've provided a few hundred billion of loans against government bonds and bank assets. But you're expecting to get paid back on those.

There's a potential saviour, oddly: if the ECB's loans do go bad, at least the money they've paid for the bonds will go towards creating an extra monetary stimulus to assist European economic recovery. But with the ECB's current attitude, it seems that may be the only way to get one. If the borrowers manage to muddle through and keep paying back what they've borrowed, meaning neither monetary nor fiscal stimulus can operate, then the EU will continue to stagnate.

Either way, if the ECB refuses to print more money, then as Stephanie Flanders says, Ireland's problems will soon land on the shoulders of the rest of the EU. The German government really ought to withdraw its implicit veto on quantitative easing.

Update: One note of interest. The Irish state, as we know, has bailed out its major banks. What they have not done - as far as I can determine - is directly funded those banks, to the full extent of their debts, with public cash. Instead, they have injected a smaller amount of capital, in order to keep the bank (now under public ownership) solvent. The large figures given above primarily consist of implicit promises to pay the banks' debts as they fall due.

Note that this creates a huge temptation, intermediate between actual sovereign default and no default at all. If the Irish government is short of €10 billion at some point next year, it could simply change its policy on bank guarantees and let Anglo Irish default anyway. This could be presented as not a real sovereign default - the Irish state can still pay its bills - but just a decision to step away from its guarantee of the banking system.

Would that be any less bad than a "real" default? I don't know. But the possibility will surely be a huge focal point for risk.

Tuesday, 28 September 2010

A story of perfect pricing

Thanks to Jonah Thomas, commenter on Marginal Revolution, for this beautiful story:


I once talked to a Marine who had served in the Philippines. There was a guy who sold bananas right outside the base. He sold one bunch of bananas for ten cents, and he sold three bunches of bananas for 35 cents. The Marine tried to explain to the man that his pricing was wrong. "Look. I buy one bunch of bananas. Here's a dime. I buy a second bunch of bananas. here's another dime. I buy a third bunch. Three dimes. I came out ahead! I got 3 bunches of bananas for thirty cents! But you wanted to sell them for thirty five cents!" The man would stare blankly at him and never understood, no matter how hard he explained. Lots of Marines tried to explain it and the man never figured it out.
Later my friend noticed that in town he could buy a bunch of bananas for 3 cents.

Monday, 27 September 2010

Fellatio targeting

The French MEP and ex-justice minister Rachida Dati has entertained legions of Youtube viewers with a slip of the tongue - intending to state that "inflation" was close to zero, but instead claiming "fellatio" was close to zero.

Fortunately, we hear, the European Central Bank is responding in a timely manner to this problem, with a "moral easing" or ME policy. In contrast to its attitude to inflation, the ECB board - especially its French and Dutch members - are quite concerned about a shortage of fellatio in the economy. They are willing to print as many euros as it takes - and distribute them wherever necessary - to return fellatio to its trend rate. As precedent they have cited Oval Office policy during the Clinton administration.

Some economists have claimed that fellatio targeting is not the appropriate measure, and instead the overall level of orgasms in the economy (also known as NGDP, or Number of Groans Derived from Poking) should be the concern of the authorities. However, even these theorists agree that 4% fellatio would be better than none at all.

Ben Bernanke is thought to have been unable to form a consensus on this point within the Federal Reserve Board of Governors. The Fed, influenced especially by Bible Belt governors such as the president of the Kansas Federal Reserve, is instead pursuing a policy of "mopping up" whatever excess liquidity had been produced by its previous loose policy. This strategy, also known as sterilisation, is intended to combat an inevitable softening of the dollar as a consequence of the earlier swelling of excess reserves and the continuous thrust of monetary policy during the financial crisis, which climaxed with an uncontrollable surge of currency onto the Fed's balance sheet (an outcome which the American people refused to swallow). The Fed is thought to be concerned about the outbreak of "hyperfellatio", a runaway spurt of fellatio in which virtually all productive economic activity is brought to a halt and citizens are seen in the streets carrying wheelbarrows full of...

...full of dollar bills. What did you think I was going to say??

Sunday, 26 September 2010

The shrinking names of economists

Paul Krugman bemoans an externality imposed on him by Narayana Kocherlakota (or his ancestors): the need to fit more letters into a short column, the more he is discussed.

While this problem has been solved over at WCI (see what I did there?) by compressing him to NK, this is a risky policy due to the frequent mentions of New Keynesian models alongside his name.

Paul suggests that all economists should have short names like Ip and Ng.

If this a problem now, surely it was a bigger problem in the days of mechanical movable type. With modern typesetting software and the greater readership of electronic media, long names are now more affordable to the reader.

We can test this hypothesis statistically. Let's start with the founders of economics in the 18th century: Hume, Smith and Mill. So far, so good. Indeed, the first entry in my Routledge "Fifty Major Economists" is the tiny-surnamed Thomas Mun.

In the 19th century the theory was developed further by Ricardo, Edgeworth and then Marshall. We even see the first eighteen-letter name with Eugen Von Böhm-Bawerk.

As the twentieth century arrives, the names lengthen further: Schumpeter, von Neumann, Samuelson and Modigliani become common currency. Douglass North even has room to add an extra 's' to the end of his first name.

And today, the rise of twelve-and-more-letter surnames gives us not only Kocherlakota, but also Leijonhufvud, Eichengreen, Mullainathan, Georgescu-Roegen, two Bhattacharyas (actually, one of them is a Bhattacharyya), the amazing Berrak Buyukkarabacak, Leandro Prados-de-la-Escosura,
Bruno van Pottelsberghe de la Potterie, and someone who would never have broken through the glass ceiling of Gutenberg: Katrin Assenmacher-Wesche.

Even controlling for Sri Lanka, this effect is striking.

Now of course, despite the lower marginal cost of an additional letter in the name, it's still an advantage to have a shorter one. Not only will Paul Krugman mention you more often in his columns, but it's easier to remember and there's nothing better for your citation count than having people remember your name.

Even today, Krugman, Mankiw and Sen are cited more often than Leijonhufvud or van Pottelsberghe de la Potterie. Of course their work may not be directly comparable, but we can also examine exact substitutes such as Cowen and Tabarrok - undoubtedly Cowen gets more of the glory there. Who can you remember better: Arrow or Debreu? Which is more prestigious: the Nobel or the Bates Clark medal?

I think Krugman has hit on a fundamental factor which explains much of the success of economists. If only this principle could be extrapolated to the actual economy. We might be able to find out why the USA is richer than Bosnia-Herzegovina. A mystery that has puzzled macroeconomists for decades.

The economics zeitgeist, 26 September 2010

This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the email box on the right and you'll get a message every week with the new cloud.


I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too.

I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Saturday, 25 September 2010

Noun, noun, noun, noun, noun, noun, noun, verb

News headlines naturally need to be compact and punchy, and they have a certain distinct grammar which is recognisable at a glance. Often a noun is used as an adjective, or a verb elided, as in "Labour leader vote close".

But the headline I saw on the BBC website today takes this principle just about to its outer limit. Six nouns are converted into adjectives one after the other, each one raising the stakes of an extraordinary portmanteau noun phrase:
MS charity respite home closure protest vote fails
The story is here, if you can figure out quite what it means.

Friday, 24 September 2010

Emergent cognitive order

As I've mentioned here before, I'm conflicted about Austrian economics. While I disagree strongly with most of its political conclusions, I think it asks many of the right questions - especially in its seminal works, such as von Mises' On Human Action.

Pete Boettke in this post shows that, despite being surprisingly wedded to a narrow, libertarian strand of political opinion, the Austrian movement is still interested in much bigger and more intriguing questions than what the right level of taxes is. His colleague Virgil Storr has been appointed editor of the journal Studies in Emergent Order.

Let me use this opportunity to briefly mention some of my ideas in this area, placing a marker for future, deeper exploration of them.


First: the notion of emergent order is critical to economics. The high level behaviours and structures of many complex systems arise from low-level components that apparently have little in common with them. The human brain is perhaps the canonical example - the thoughts and actions which come out of it appear to have nothing to do with the simple neurons of which they are made. The windows, documents and music which pour out of a modern computer do not share their shape or nature with the silicon transistors on which they are built. And the images that are placed in your head by a great novel or even a mundane blog - just think of a rippling meadow of yellow daffodils, or the aroma of a bacon roll - are completely distinct from the series of ink strokes or pixels which makes the shapes of the letters which describe them.

Some of these high level structures are imposed on their smaller components by an author or inventor of some kind. But those which are not - like the brain - can truly be said to emerge from the natural interactions of the small components. And the economy is one of these emergent systems. Macroeconomic phenomena are natural consequences of the desires of, and constraints on, the millions of individuals that interact in an economy. There is no need for a designer to create the economy. The study of economics is more about discovering which kinds of phenomena will emerge, given the basic rules that people follow.


Second, the emergent behaviours depend not just on the nature of the individual, but also on the individual's relationships to others in the economy. These relationships often do not arise automatically. They are learned over time; they spread through communication; they rise and fall dynamically; and they depend in each moment on the relationships that existed in the moment before. The study of these relationships is often neglected in economics, but the subject cannot be understood without them.

What form do these relationships take? Knowledge. Trust. Laws. Learned preferences. Social groupings and comparisons. Economic institutions. None of these are natural to the individual, nor can they exist solely as properties of a single person. And yet they do exist inside the individual heads of people. They are perhaps best thought of as a shared mental state of many individuals, combined with mechanisms to communicate and confirm that state through language.


Third, the nature of the individual, of the shared mental states and of the language that communicates them are not accidental. Instead, they can be derived from the necessary conditions which a cognitive being must fulfil, combined with an understanding of the kinds of organism that would thrive or survive under evolutionary pressures.

This is the reason why neuroscience is a distraction in economics. All of the important aspects of human behaviour, anything that matters economically, can be derived from first principles without the need for any knowledge of, or experiments on, brain biology. Cognitive biases towards the short term, the status quo and objects currently or recently visible, biases against risk and loss, heuristics which approximate extreme probabilities, and social phenomena like emotions and trust, are natural attributes of any plausible thinking being. The only open question - where neuroscience might have some small contribution to make, but behavioural experiments are much better - is how strong these traits are.


Since the low-level attributes and the high-level emergent phenomena are dependent on each other, modelling them is not an obvious matter. But economics does have some useful tools to help - whatever the weaknesses of simplistic rational expectations and general equilibrium models. A joint derivation of the low and the high level structures is, in fact, the key foundation project of cognitive economics. From that point, a deeper understanding of individual choices and macroeconomic dynamics will swiftly emerge.

Thursday, 23 September 2010

Birthdays

The blog has been a bit inactive the last couple of weeks as I've been in Spain celebrating my brother's 30th birthday, followed by a bit of holiday time. Just arrived back, and ready to get some new ideas into writing.

In the meantime, a message kindly provided to me in one of my own birthday cards, a couple of weeks previous:
Birthdays are good for you.
Statistics prove that the people who have the most live the longest.
  - Larry Lorenzoni

Sunday, 19 September 2010

The economics zeitgeist, 19 September 2010


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the email box on the right and you'll get a message every week with the new cloud.


I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too.

I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Wednesday, 15 September 2010

What is the difference between cognitive economics and behavioural finance?

This question was posed in an interesting LinkedIn discussion group (Behavioural Finance: Theory and Practice) by Kerry Pechter.

I dashed off a quick answer which ended up being 500 words long. So I thought it might be useful to post on here.

Can anyone tell me the difference between cognitive economics and behavioral finance?

Cognitive economics is not yet a widely used phrase, though Marco Novarese and I have been using it as a name for a more microfounded version of what's typically called behavioural economics.

So I'll answer the question based on how I use the term.

The first difference is between "economics" and "finance". Economics is a broader field, including the trading of any kind of goods or services, whereas finance specifically focuses on investment and the value of financial instruments. Indeed I consider economics very broadly to be the study of how resources are allocated (by individuals, and across society).

The more fundamental distinction is between "cognitive" and "behavioural". In short, cognitive is about how we think, while behavioural is about what we do. Behavioural finance and economics focus on the phenomena of how people behave - for example what will they do (on average) when faced with a given choice between two ways of paying for something?

Cognitive economics (or finance), on the other hand, looks at what is actually going on within the individual's mind when they make that choice. What is the internal structure of their decision-making, what are the influences on it, how does information enter the mind and how is it processed, what form do preferences take internally, and then ultimately how are all those processes expressed in our behaviour?

I would also distinguish between the way that behavioural economics and finance are practised, and what cognitive economists do. Behavioural economics is quite an experiment-driven field. BE (and BF) people mostly start from the framework of classical economics and do experiments to find out where real behaviour differs from the classical assumptions of rationality. BE is quite practical in one sense - it gives us a way to imagine the ways that people might behave when confronted with a given situation. However it does not make good predictions about how they will behave - generally it will rely on experiments to distinguish among the different possible behaviour modes.

Cognitive economists start at a lower level, from a microfounded model of how people make decisions, and work upwards theoretically, to develop a self-consistent model of large-scale economic behaviour. Cognitive economics therefore should ultimately be able to explain or predict behaviour from a minimal set of base data. In some ways this is the same goal as classical economics, but with a richer and more accurate microfoundation leading to more powerful and better micro and macroeconomic predictions.

A simpler way to explain it is by analogy with the difference between engineering and physics. Behavioural finance is like engineering - engineers know some rules about how objects behave, and they can use those rules to design and test new implementations of existing inventions, and fix things that have already been built. Cognitive economics is like physics - physicists know the underlying theory of how things work, and they can use that to explain how existing inventions operate, and to work out how to create wholly new ones.

Sunday, 12 September 2010

The economics zeitgeist, 12 September 2010


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud.


I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too.

I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Tuesday, 7 September 2010

That overwhelming 8% majority



See that "Most believe retirement is over" link on the right?

When you click on it, you get the article on the left.

Which says that fully 8% of people expect never to retire.

I know that the definitions of some words are variable, and subjective, and that reasonable people can disagree even on the meaning of "majority". The US Senate certainly does.

But it's rather difficult to stretch the definition of "most" to mean 8% of people.

Sunday, 5 September 2010

The economics zeitgeist, 5 September 2010


This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud.


I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too.

I use Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.

You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.

Thursday, 2 September 2010

Minimum drink prices - responsibility or idiocy?

[Update 05/10/2010: UK home secretary Theresa May has announced today at Conservative Party conference that the government will be imposing a similar policy at UK level - banning the sale of alcohol below cost. "Below cost" is almost impossible to define - how much fixed costs do they include? - but at least it's not quite as simplistic as the Scottish version. Still not a smart policy.]

Today the Scottish Executive announced that it wants alcohol in Scotland to be sold at a minimum price of 45p per unit.

From time to time, governments around the world have imposed maximum prices on various products - petrol is a typical one - usually with the intention of helping their poorer citizens, and with a secondary effect of causing shortages.

The Scottish Executive's goal is instead to reduce consumption - and setting a minimum price is, according to economic theory, a valid way to do that. Naturally, if two litres of cider has to be sold at £3.80 instead of £1.32, fewer people will buy it.

But there will be other consequences too.

The short-run effect will be an increase in the gross margins of retailers. Currently, that cider costs them 70p and is sold at £1.32 - a markup of 88%. After the floor price is introduced, the cost will still be 70p - but it will be sold for £3.80. That's a markup of 442%! This sounds like a great bonus scheme for retailers at the expense of low-income drinkers.

This is one reason why most economists would suggest a tax instead of a minimum price. If a 35p/unit tax were imposed on alcohol, at least the public purse would benefit instead of the supermarkets. Then, the disproportionate impact on poor people could be balanced with an increase in public spending or benefits to that group. And the cost would be imposed across all alcohol drinkers instead of cut off at an arbitrary limit.

However, the tax has two political drawbacks:

  1. It is a tax. People don't like taxes (even in Scotland)
  2. It would hit middle-class people as well as cheap cider drinkers. The minimum price, because it will only affect cheap alcohol, affects mainly poor people - who are less likely to vote and are not politically influential (even in Scotland). And it's hard to target the tax to affect only cheap products, because retailers would simply raise their prices to avoid it, and we'd have the same situation as in the proposed law.
So we won't have a tax, we will have a minimum price. But the effects of that are more complicated than they appear at first.

Aside from the increase in retailer margins, we would of course expect a reduction in volume of alcohol sold. However, it is likely that total alcohol revenues will go up. Supermarkets are not currently maximising revenue because there is competition between them ensuring they keep prices lower than the optimal (monopoly) level. This policy would effectively remove some competition and probably allow them to generate more revenue. Whether revenue goes up or down depends on whether elasticity of demand is less than or greater than 1. I suspect that overall alcohol demand is not very elastic, so revenue should go up.

The next effect is a substitution towards higher quality products. If you now have to pay £3.80 for 2 litres of appalling cider, you may as well spend the same £3.80 on some decent cider. Or you could buy Magners.

Some people may prefer the cheap cider, but over time those habits - formed out of cheapness - will diminish. Competition will operate on quality instead of price, driving up what you get for your money.

There's only so much extra sales you can get from incremental quality improvements - so manufacturers are likely to compete on incentives instead. We would expect to see lots of generous competitions on cider bottles - giving away holidays (perhaps to countries where alcohol is cheaper) - or free gifts, or other non-price-based promotions.


And whether the customers buy cider-with-a-free-holiday or Magners, the manufacturers' prices will be higher, and the retailers' margins back down to the more normal level of 40-50%. So some of those extra retailer profits will go away.

Indeed, with a normal level of margin but a reduced volume, retailers would be expected to end up with lower profits in the long run than at present.

On the other hand, whoever makes Magners (an Irish company called C&C) will do better, at the expense of whoever makes White Lightning. The low-cost producers may go out of business or have to reinvent themselves. Interestingly, Heineken last year discontinued production of White Lightning in order to "cease encouraging irresponsible drinking". I wonder if they foresaw this effect or if it was purely a public-image decision.

A further outcome will be an income effect on those who cannot (or choose not to) reduce their alcohol consumption. Some poor people may become poorer. Some might even become homeless. Thus, if the main concern of policymakers is to reduce the number of drunks on the streets of Glasgow, they might be better to reduce the price of alcohol than to increase it.

And of course, one hidden loss will be a reduction in the happiness of drinkers. Any time the government removes a choice that citizens currently have (to buy or sell cheap alcohol), some people who would have made that choice will have to opt for a less attractive option. Perhaps the increased happiness of others will compensate for this, but the cost should at least be acknowledged.

So the Scottish Executive is proposing a policy to benefit Magners at the expense of cheap local producers, impoverish its poorest and most vulnerable citizens and make Scotland a more miserable place. Sounds like the perfect SNP policy.

Wednesday, 1 September 2010

Kocherlakota has a mentor

Paul Krugman (quoting Jan Hatzius) uncovers another scary article from another Fed president:
Third, the statement seems to be at odds with a recent article by President Bullard of St. Louis suggesting that a continuation of the Fed’s current stance on short-term interest rates could result in deflation (see “Seven Faces of ‘The Peril’”, July 28, 2010). The first sentence of the abstract reads: “In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.”
The original report from Bullard can be found here. Guess who is thanked in the footer of page 1? Narayana Kocherlakota (as well as David Andolfatto, regular blog commentator on Worthwhile Canadian Initiative and TheMoneyIllusion).

So what's going on? The paper is making the same argument for which Kocherlakota has been pilloried over the last two weeks. But the paradoxes in that paper are layered with yet more contradictions:
  1. Hatzius quotes the FOMC minutes which say that there is little risk of deflation - and yet Bullard, who is on the committee, is arguing that the Fed's low interest rate policy may itself cause deflation.
  2. Hatzius, like Krugman, is disagreeing with the FOMC's view and agreeing with Bullard that there is a risk of deflation but their prescription is the opposite of Bullard's - keep interest rates low.
  3. Bullard comes to the same bizarre conclusion as Kocherlakota - low interest rates cause deflation - but then deduces from this a sensible corollary - we should continue quantitative easing!
  4. Bullard came up with all this before Kocherlakota - in fact for all we know, Kocherlakota got his speech from reading Bullard - but Kocherlakota got all the blame.
  5. While everyone thinks Kocherlakota is very hawkish, Bullard is described as a dove.
I won't go over again all the reasons that Bullard and Kocherlakota are wrong - Andy Harless, Nick Rowe, Scott Sumner and Karl Smith have done that very well.

But the chain of logic here has so many inversions that I think I'm in a Borges novel.

p.s. this paper was already spotted by Money Demand last week.